Federal Court Strikes Down Limitation On Joint Employer Liability
By James M. Mulcahy and Allard Chu on September 11, 2020
On September 8, 2020, a federal district court in New York partially granted a motion for summary judgment striking down a portion of the U.S. Department of Labor’s final rule (the “Final Rule”) narrowing the definition of joint employment under the Fair Labor Standards Act (“FLSA”). The case, State of New York v. Scalia (Case No. 1:20-cv-1689), arose out of a challenge to the Final Rule by 18 states, alleging a violation of rulemaking procedures under the Administration Procedure Act (“APA”). The Final Rule had established a four-factor test for determining whether a person is a joint employer, replacing a more amorphous set of factors relating to economic dependence. The court struck down the four-factor test, potentially reopening franchisors to liability as joint employers of their franchisees’ employees.
Fair Labor Standards Act and Joint Employer Liability
The FLSA, enacted in 1938, was designed for the protection of workers from substandard wages and oppressive work hours. Over the decades, the FLSA has been the subject of legislative amendments as well as Labor Department guidance in the form of administrator interpretations and ruling letters. It applies broadly, due to expansive definitions of the terms “employee,” “employer,” and “employ,” which are designed to ensure comprehensive coverage of working relationships. In the seminal Rutherford case in 1973, the U.S. Supreme Court adopted an “economic reality” test for employment relationships.
Joint employment typically refers to an arrangement where an employee only works directly for one employer, but another person benefits from the employee’s work. The concern for the franchising industry is that the joint employment concept could be used to hold franchisors liable for all employment-related decisions of their franchisees. The idea of “joint employment” – where multiple employers could simultaneously be deemed employers of the same employee – was recognized by the Labor Department early on in an interpretative bulletin. Congress codified this concept in 1958.
Although they were not historically defined, there are broadly two types of joint employers: horizontal and vertical. In a horizontal arrangement, an employee works for one employer in one time period and works for a second employer in another time period. In a vertical arrangement, the employee only works for one employer, but another person benefits from the employee’s work. It is this vertical arrangement and potential consideration as a joint employer that concerns franchisors because of the arrangement of franchisor, franchisee, and the franchisee’s employees.
In 2014, under the Obama administration, the Labor Department’s interpretation of the scope of employment for joint employment fell in line with the broad scope of the FLSA. Building off of the Supreme Court’s test of “economic reality” for employment relationships, the Labor Department generally viewed joint employment through the lens of the FLSA’s statutory definition of the term “employ.” With respect to the FLSA, the Labor Department noted that courts had already rejected a narrow interpretation of the FLSA definition of “employ” as requiring the “right to control.” Accordingly, the test for joint employment should also be one of economic dependence and examination of whom the employee is economically dependent upon.
The Final Rule at Issue in the Lawsuit
On April 1, 2019, the Labor Department published a Notice of Proposed Rulemaking (“NPRM”) to “revise and clarify the responsibilities of employers and joint employers to employees in joint employer arrangements.” In the NPRM, the Labor Department proposed a four-factor test for determining joint employment. Following the end of the comment period for the NPRM, the Final Rule was issued and took effect on March 16, 2020.
For vertical joint employer situations, the Final Rule narrowed the basis for determining a joint employer to a four-factor test of whether the employer:
- (1) hires or fires the employee;
- (2) supervises and controls the employee’s work schedule or conditions of employment to a substantial degree;
- (3) determines the employee’s rate and method of payment; and
- (4) maintains the employee’s employment records.
Importantly for franchisors, the Final Rule also included discussion regarding franchisors and provided that “[o]perating as a franchisor . . . , or using a similar business model does not make joint employer status more likely.”
These changes significantly eased franchisors’ potential concerns about being a joint employer for the employees of franchisees if franchisees commit FLSA violations. By and large, most franchisors do not have control over any of the four factors listed in the Final Rule. Instead, franchisors are simply licensing trademarks to franchisees; as independent business owners, franchisees retain control over the hiring, direction, terms of employment, and firing of their employees.
Failure of the Final Rule to Comply With the Administrative Procedure Act
The state plaintiffs argued that adoption of the rule violated the APA because it contravened certain language in the FLSA and because it was inadequately explained by the Labor Department. The court agreed. The vertical joint employer test, it held, “conflicts with the FLSA because it ignores the statute’s broad definitions. Moreover, the Labor Department “failed to adequately justify its departure from its prior interpretation.”
In review of the Final Rule, the court found that the four-factor test was “impermissibly narrow” and was effectively a proxy for a control-based test. As the FLSA was significantly broader in determining employment than a control-based test, the four-factor test was improperly limiting. Although the four-factors can be relevant, or even sufficient, to the determination of a joint employer, it cannot be the sole determinative test.
As a result, the court struck the four-factor test of the Final Rule.
Potential Concerns For Franchisors
With the court’s ruling, the standard for determining a joint employer will revert to a broad interpretation in light of the FLSA and economic dependence. This reversion brings about renewed concerns for potential franchisor liability for the employees of franchisees. Without the significantly narrower four-factor test, franchisors are left wondering whether an employee has sufficient basis for economic dependence.
There is currently no bright line rule for whether a franchisor qualifies as a joint employer. Several cases around the country have found that franchisors were not employers within the meaning of the FLSA. For example, in Singh v. 7–Eleven Inc., a California federal court found that control of store hours, uniforms, and food services were insufficient to show that the franchisor was a joint employer. Singh v. 7–Eleven Inc., No. C05–04534–RMW, 2007 WL 715488, at *3–6 (N.D. Cal. Mar. 8, 2007).
However, these cases are anecdotal at best, and far from conclusive. Based on the near century-long history of the FLSA, franchisors may be waiting a while for more clarity. For now, franchisors should remain cognizant of avoiding any control or influence over the hiring, direction, terms of employment, and firing of franchisee’s employees.
This article was prepared by James M. Mulcahy (email@example.com) and Allard Chu (firstname.lastname@example.org) of the Irvine law firm of Mulcahy LLP. Mulcahy LLP is a boutique litigation firm that provides legal services to franchisors, manufacturers and other companies in the areas of franchise, trademark, trade secret, unfair competition, and distribution laws.
Disclaimer: While every effort has been made to ensure the accuracy of this article, it is not intended to provide legal advice as individual situations will differ and should be discussed with an experienced franchise lawyer. For specific technical or legal advice on the information provided and related topics, please contact the author.